Quite a few people seem to dislike a column I wrote earlier this week on exchange-traded funds and their role in the emerging market sell-off. So let me offer a little extra data that was not in the earlier piece.
The following chart, compiled from Strategic Insight Simfund data, shows total inflows and outflows from US investors to emerging market equity funds of three types: active funds, indexed open-ended funds, and indexed ETFs. Figures are in billions of dollars. Starting in 2009, when emerging markets began their rebound, and going through to the final quarter of last year, I believe the story it tells could not be much clearer: ETF money is flighty.
Money in ETFs is far more volatile and far more prone to exit in a hurry than money invested in emerging markets through other vehicles. As EM investing is supposed to be a game for the long term, this is a problem.
How exactly should we benchmark hedge funds? It is obviously unfair to compare them directly to equity indices, as the whole point of hedge funds is to aim for an “absolute” return, not a return relative to gains in the equity market. They will naturally under-perform an S&P 500 tracker in years like 2013 when the stock market shoots straight up.
I drew attention last week to the way hedge fund returns have been left badly behind by long-only equity returns over the five years of the post-crisis relief rally, and this understandably provoked comments that this was an unfair comparison. There are also obviously many methodological problems with creating hedge fund indices. Hedge funds have many different strategies, and they may be particularly prone to “survivorship bias” – those that do not have a good story to tell tend to shut down quietly, and do not tell index compilers about their record.
However, hedge funds do have to accept that their offerings will be used by asset allocators trying to use them to balance against the main asset classes of equities and bonds. On that basis, the following chart, produced by Barclays’ capital solutions group using HFRI indices, is very interesting.
It confirms a basic intuition: hedge funds did very well during the bursting of the dotcom bubble, more than held their own during the subsequent 2002-2007 rally, and have had a far harder time of it in the last five years. Why might this be?
The Bank of England has hit the target at last. UK inflation is at 2 per cent, bang in line with the Bank’s target, for the first time since the end of 2009. This is good news for the UK, which had been buffeted by an incipient inflation problem. But it is part of a global trend that could be far more problematic: deflationary pressure.
As the chart shows, the BoE now completes a set of all the four major developed market banks – along with the Federal Reserve, the Bank of Japan and the European Central Bank – to have inflation at or below the target of 2 per cent.
At first, the idea that the Nobel economics prize should be shared between Eugene Fama and Robert Shiller sounds absurd – akin to making Keynes and Friedman share the award.
Gene Fama, of the University of Chicago, is famous as the father of the Efficient Markets Hypothesis, after all, while Yale’s Bob Shiller is famous primarily for being the principal critic of that hypothesis.
Russell Napier’s Anatomy of the Bear seems to be quite a cult classic among investors. I regularly see it on portfolio managers’ desks. Meanwhile, his video interviews with the FT in the years since the crisis also seem to have created quite a cult following. This week he completed his fourth interview with us since 1999, and he is sticking to his claim, based on historical experience, that the S&P 500 will need to slide down below 500 once more before this bear market is over (he did say 400 in the book).
How much has his story changed, and how seriously should we take him? This obviously divides opinion. So here are his previous interviews with us, in chronological order.
Just what depths of political stupidity are markets discounting? The partial shutdown of the US government passed with little or no impact on the markets that stood to be most affected, even though there was uncertainty about it to the end.
Almost all European stock markets opened higher, despite the news from the US. The dollar index dropped 0.35 per cent in the minutes following the realisation that the shutdown would happen, and then recovered somewhat. The yield on the benchmark 10-year Treasury bond gained 5 basis points to 2.66 per cent – still far below the 3 per cent it briefly touched a few weeks ago. So what has happened so far – the failure to agree on a budget and an initial shutdown of the US government – has evidently been priced in.
We all now know that the Federal Reserve opted not to “taper” last week. In other words, it kept its monthly purchases of bonds at $85bn without reduction, in a move that was a surprise to many, even if the FT had made clear for a while that a taper was no foregone conclusion.
But have others been tapering already? The official Treasury Department data show that foreigners have this year started very gently selling down their positions of Treasuries. This is the chart:
The move is not great, but it is there. To be precise, foreign holdings of Treasuries reached $5.72tn in March, and by the end of July were at $5.59tn. This is no great change in itself, but it is changes at the margin that matter – and we already know that a “taper” or otherwise in the Fed’s bond purchases was able to generate a dramatic market reaction. So what is going on?
Lehman has, at last, been bankrupt for five years. I posted the last of the five-video series we put together for the anniversary here. This post is for those hardy few who have still not had enough of Lehman memorabilia. If you have the time and inclination, try looking through some of these videos, which I made at the time (when I was based in New York and still covered the Short View).
First, this video, which we produced for what we then considered to be the first anniversary of the crisis, in August 2008 a few weeks before Lehman, bears re-watching. The key message to be derived from it is that claims that nobody saw the Lehman bankruptcy coming, or the crisis that surrounded it, do not hold water. It features today’s interviewee, the former Olympic fencer James Melcher, and his comments are particularly prescient:
The Lehman bankruptcy was five years ago, as you may have noticed. Five years on, it is surprising what aspects of the pre-Lehman landscape have survived, and which have vanished. This came out in today’s Note video with Larry McDonald, author of A Colossal Failure of Common Sense, and a Lehman alumnus:
Note that while the recovery in the financial system has been in many ways remarkable, the securitisation market remains as dead as a dodo. These charts tell the story. First, here are the figures for asset-backed securities:
So there is a recovery in auto loans, but securitisation of home equity loans, by which Americans turned their homes into ATMs, seems to have ended. Next we can look at CDO issuance (not for the squeamish):
Maybe we should reinstate Glass-Steagall. Or maybe we should revisit the system of publicly quoted banks. That at least seems to be the implication of comments made to me by John Reed, who spent almost two decades as the CEO of the old Citicorp and then joint CEO of the newly formed Citigroup. You can find text from my interview with him here and here.
However, I think it is worth highlighting still another passage, as it cuts to the heart of how banks should be valued, and arguably even how they should be owned. He now believes that commercial banking and trading cultures should not be combined. When I pointed out that trading can boost returns, he made the following response:
I could understand that an institution might want to bridge both businesses. If someone like Deutsche Bank were to be only a commercial bank it would be a quite different entity. They’ve used that investment bank to change their earnings profile and their ROE [return on equity] targets. They have a 20 per cent target for ROE.* You could not achieve that in Europe with a commercial bank. You have to get heavily into the markets to imagine getting those kinds of returns.
I think the industry would be healthier if instead of looking at returns they look at p/e [price to earnings] ratios. The more you become a trading organistion, the less your p/e. You should aspire to be like Coca-Cola and have a 20 times p/e.
Obviously the numbers are approximate, and the figures for Deutsche need to be updated. To be more precise, Deutsche under its former CEO Josef Ackermann had a 25 per cent “pre-tax ROE”, which our banking editor Patrick Jenkins suggests would be more like 16 or 17 per cent under German taxes. At present, Deutsche’s ROE, which varies considerably from quarter to quarter, is more like 12 per cent. But the validity of Mr Reed’s point is unaffected, as is clear from this chart. Coke is the blue line here (note Citi’s price/earnings ratio went almost to infinity as it was seen returning from loss to low earnings in 2010). Aside from the rude interruption of the great financial crisis, the point stands that the market will pay a much higher multiple for the earnings of a consumer branded company that it will pay for the earnings of a universal bank.
Note: Citi high PE reflected negative and then v low earnings
There then comes the issue of whether Glass-Steagall or something like it should be reinstated, forcing commercial banks to divest their trading arms. Banks have lobbied fiercely against this. Mr Reed suggests that this is against the public interest: